The word bubble gets tossed around loosely these days. Depending on who you listen to, there’s a bubble in stocks, bonds, housing, cryptocurrency, and a few others I’m surely missing.
There’s no way it’s all true. Not everything has to end in a bubble and a crash but it will happen eventually because humans are great at finding new ways to repeat history.
Of course, Warren Buffett and Charlie Munger have made a career of profiting from those repeated mistakes. Their understanding of history, human nature, and the experience of a few bubbles in their time allows them to recognize and avoid what draws so many people in.
Buffett explains why it happens this way:
There’s no question that markets have momentum. And that when there is enough momentum, it takes over everything. I mean, when you — that’s how you get bubbles.
Ben Graham used to say you get in more trouble with a good idea than a bad idea because the good idea you originally had — the idea that stocks were cheaper than bonds generally — after a while, the very action of the stocks becomes more important than the fundamental reasons and the fundamental reasons dissapear and people buy something because it’s going up. There’s no telling how far it will go but you can be pretty sure there will be a bad ending.
This is especially true if you know nothing about the asset other than it’s going up.
I get into enough trouble with things I think I know something about. Why in the world should I take a long or short position in something I don’t know anything about?…
If you’re buying something because it went up yesterday or last week, that is not a good reason for buying anything. It will get you in trouble over time. – Warren Buffett
That’s only part of the reason why people dive in.
Seeing other people quickly making money also draws investors into speculative bubbles. There’s also a smattering of success stories in the news that heightens the fear of missing out.
So greed plays a role but envy is what drives people to make the mistake of chasing what appears to be easy money.
Investing can be frustrating at times. Intelligence and skill are not prerequisites for making money. You can be smarter, more skillful, and more experienced than millions of other people who play the game. Yet, there will always be someone — less intelligent, skilled, and experienced — who outperforms you in any given year.
A slim chance exists for anyone to make a quick fortune. Dumb luck happens. It’s frustrating to watch. Yet, it’s enticing. It’s what draws new people into the markets all the time.
It’s just that dumb luck is not a strategy you can really on because it almost always leaves you worse off than you started. And on the rare chance that it doesn’t, it brings a risk of confusing dumb luck with skill.
Charlie Munger’s answer to all of it is to give most things a wide berth:
When there’s enough incentive, bad things will happen. It’s bad people — crazy bubble, bad idea — luring people into the concept of easy wealth without much insight or work. It’s the last thing on earth you should think about. If it worked it would be bad for you, because you’d try and do it again. It’s totally insane.
And by the way, I’ve just laid out a wonderful life lesson for you. Give a whole lot of things a wide berth. They don’t exist. Crooks, crazies, egomaniacs, people full of resentment, people full of self pity, people who feel like victims, there’s a lot of things that aren’t going to work for you. Figure out what they are and then avoid them like the plague…
And the worst thing would happen if you won, because then you’d do it again. It’s total insanity. And it’s so easy to simplify life from just all these things are beneath you.
Few people make a fortune overnight.
Investing is hard. It takes time. It doesn’t require a ton of intelligence.
You do have to be smart enough to know what you know so can avoid what you don’t know. And you need the discipline and patience to follow through.
This post was originally published on January 10, 2018.